Most insurance companies fall into two categories participating and non-participating. Whether or not the company pays dividends to its policy holders divides them.

Participating - Insurance companies that pay dividends are considered to be participating. In other words the policy holders are "participating" in company profits paid through dividends. Typically participating policies are offered by mutual insurance companies, but they can also be offered by stock insurance companies.

Nonparticipating - Insurance companies that do not pay dividends are considered to be nonparticipating. These companies do not distribute any gains or profits to policyholders. They typically will return any gains to shareholders.

Practice Question: Jack is a shareholder and policy holder in AMC Corporation. Last year he paid $10,000 in premiums for his life insurance policy. In November of that year he received a $500 check in return for extra premiums not used by the company. What type of policy is this considered?

Answer: A Although the insurance company is owned by stockholders it can still distribute any profits or gains exceeding expectations for the year. These dividends are distributed according to dividends not used in the year.

Using the example above, how much of the $500 dividend must Jack include in his taxable income.

A. 100% B. 50% C. 25% D. 15% E. 0%

Answer: E Dividends received from participating insurance companies are generally received income tax free.